Bonds bad credit
A junk bond is issued by a corporation or municipality with a bad credit rating. In exchange for the risk of lending money to a bond issuer with bad credit, the issuer pays the investor a higher interest rate. "High-yield bond" is a nicer name for junk bond. A junk bond (or high-yield bond) is one with a credit rating of BB or lower and that carries higher risk of interest or principal default than better rated investment grade bonds. Junk bonds are issued in leveraged buyouts and other takeovers by companies without long track records of sales and earnings, or by those with questionable credit strength.
What is a bond?
When a corporation or municipality borrows money from an investor, it gives the investor a bond. The bond is like an IOU or promissory note -- it states the amount that will be paid back, when it will be paid back, and what interest will be paid on the borrowed money. Bonds come in two grades:
- Investment grade bonds: Those that Standard & Poor's and Moody's rate as carrying no more than medium risk and at least medium quality.
- Junk bonds: Those with high risk and below medium quality, and those in default.
How do I know if a company or municipality has a bad credit rating?
Standard and Poor's and Moody's are the bond-rating systems used most often by investors. Their ratings are as follows:
| Moody's | Standard & Poor's | Grade | Risk |
| Aaa | AAA | Investment | Lowest risk/highest quality |
| Aa | AA | Investment | Low risk/high quality |
| A | A | Investment | Low risk/upper medium quality |
| Baa | BBB | Investment | Medium risk/medium quality |
| Ba, B | BB, B | Junk | High risk/low quality |
| Caa, Ca, C | CCC, CC, C | Junk | Highest risk/highly speculative |
| C | D | Junk | In default |
Should I buy junk bonds?
Never buy individual junk bonds because they are too risky. However, a high-yield bond fund can be a good addition to your portfolio if you do all of the following:
- Hold it for more than five years
- Reinvest the income
- Hold it in a tax-deferred account (IRA, 401(k))
- Make this holding a very small part of your portfolio. No more than 20 percent of your bond money should be in junk bonds
Why Junk Bonds Are Getting Junked ?
Companies are flocking to leveraged loans because they're offering the cheapest and most plentiful debt capital in at least eight years -- far better than what's available via junk bonds. The terms are so attractive that leveraged loans are pushing aside junk as a key debt instrument for leveraged buyouts. The movement toward leveraged loans goes hand in hand with the broader shift in credit markets to jack up leverage and shift risk through new instruments such as credit default swaps and collateralized debt obligations. The trouble is, leveraged loans, unlike regular old junk bonds, have floating interest rates.
The attraction for investors: floating rates, which they prefer at this point in the economic cycle because they think that long-term interest rates will climb, eroding the value of junk bonds. (When interest rates go up, bond prices go down.) What's more, in the event of a bankruptcy, loan holders have a stronger claim on corporate assets than bondholders have.
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